12 Signs That Your Club’s Sailing for an Iceberg

Time to Buy Shares in the Titanic Shipping Company?

Investment clubs fail for a number of reasons. Sometimes, clubs shut down owing to reasons related to the lives of members — a critical mass of them move away, change jobs, pass away or experience other significant life changes.

But many clubs disband for reasons that could have been prevented, if the members had only taken heed of better counsel about their operations. To that end, I’m adding my own list of the most common club problems I’ve observed that contribute to the failure of many investment clubs.

On their own, one or two of these problems won’t likely destroy an investment club. But as the issues mount, the probability that the club is headed for disaster increases, even as one or more members profess to know better than the experts and advise the club to uphold their current course toward catastrophe. No matter the age of the club, nor how long the club has been seemingly successful while operating in the gray areas of successful investment club practices, there’s no time like the present to get back on track. Just remember: If you’re headed toward an iceberg, it’s always better to steer a wide course.

1. The club treasurer is maintaining the club’s books manually. Today’s investment club software programs and websites such as myICLUB.com are so relatively inexpensive for the value that they deliver that it just doesn’t make sense for an investment club treasurer to try to manage the books using computer spreadsheets or on paper.

The results won’t be as accurate as if done using soft­­ware — for instance, it’s impossible to calculate a time-weighted annual allocation of income and expenses without using club accounting software, and the manual method can be unfair to members in some circumstances. In addition, while the current treasurer may well understand how to use a complicated system of spreadsheets, no other member may be willing to take over the Her­cu­lean task of manually keeping the books. On the other hand, there are webinars, manuals and online training available for using club accounting software, which can help new treasurers get up to speed quickly.

2. The club treasurer isn’t making regular backups of the club’s data and website. No system is 100 percent foolproof, but you can reduce the odds of a calamitous event such as a computer crash, hard-drive failure or data-entry error by making monthly backups of all computer data files. Keep a second copy in a safe, remote location as well. It wouldn’t be so bad to have a third copy in yet another location. Ask anyone whose computer has crashed if he wishes that he had used better backup procedures. Don’t be that person who skips this important step.

3. The club isn’t filing federal and — if applicable — state tax returns. General partnerships are considered pass-through tax entities, which means that all tax consequences “pass through” to the partners and are then reportable by the partners on their personal tax returns. This doesn’t mean the club gets a pass on filing its tax returns, however. The IRS and many states want to be able to match up taxable income generated by partnerships with the appropriate amounts recorded on individual returns. Clubs that don’t file could be liable for penalties, even after the club disbands.

4. The club isn’t auditing its books each year. Conducting an annual club audit is important because it can help spot slight potential problems before they mushroom into much larger problems years down the road. A club audit isn’t meant to discredit the club treasurer. It simply provides support for this important position as well as introduces other members to the facets of the treasurer’s job.

5. The club is collecting member fees to cover club expenses. Nothing can start an argument faster than trying to convince a club that’s “always done it this way” that, in fact, it has been doing it wrong all along. The rules about club expenses and how members pay for them are pretty straightforward. Any expense recorded by a club on its books is a club expense, and the club shouldn’t attempt to collect any monies toward that expense from club members. A club expense is one that benefits the club in some way; if the expense doesn’t benefit the club, the club shouldn’t be paying for it.

A problem arises when clubs try to collect “fees” from members to cover expenses. A fee should be used only for penalty situations, such as late fees, and never as a payment for services received. If the club wishes to collect addi­tional funds to offset expenses, which is entirely unnecessary, those monies should be recorded as member payments. If the club can’t follow this procedure for expenses such as BetterInvesting dues for members, the club should collect checks from members payable to BetterInvesting directly and keep the expense and the monies collected off the books.

6. The club is collecting fees to offset equally allocated expenses. Closely related to No. 5 is the problem that presents itself when a club decides that an expense should be equally allocated among all members and then records a fee from each member. Most expenses should be allo­cated by capital account, not equally. But if a club decides to levy funds from members to cover the expense, those funds should be recorded as payments, not fees. Recording fees in this situation unfairly burdens new members, however counter­in­tui­tive that may seem.

7. The club’s attempting to operate on an “equal ownership” basis. Most people want to be involved in organizations that are “fair.” In investment clubs, this often comes out as a mandate to keep all members of the club “equal.” Unfor­tu­nately, this is a mythological concoction that doesn’t exist in the real world. Even if the club manages to keep the amounts “equal” on the books, some members will benefit and some will suffer under the forced provisions of “equal ownership.” The unit value system of partnership accounting ensures that members have exactly the right amount of ownership according to their investment in the club, and nothing could be fairer or more equal than that.

8. The club always pays member withdrawals in cash. In some circumstances, such as when a club owns a stock that’s appreciated greatly in price, it’s to the club’s great benefit if it transfers that security to a fully withdrawing member instead of selling it. Clubs that never consider transferring securities in this situation could be losing out on a significant tax benefit.

9. The club maintains beneficiary statements for members. Many clubs think of themselves as being prepared when they require members to complete beneficiary forms that seem to indicate the proper dispensation of members’ capital accounts in the event of their death. Unfortunately, the legal status of such beneficiary statements is less than airtight, so following them may actually cause problems for the club. In the event of a partner’s death, simply follow the terms of the partnership agreement and present payment to the member’s next of kin and in the member’s name.

10. The club holds shares in master limited partnerships, commodity ETFs or royalty trusts. The accounting head­aches presented by master limited partnerships (MLPs), exchange-traded funds that invest in commodities or royalty trusts are all severe, and no investment club accounting tool supports these investments. Even worse, these investments wreak havoc with the asset-allocation plans of individual members.

Any time that an investment club in­vests in a security other than a common stock, it makes it more difficult for individuals to manage their own total asset class allocation, since now they need to figure the nonstock percentage of their investment club account. In addition, there are no tools such as Toolkit 6 or the Stock Selection Guide members can reliably use to analyze these alternative investments.

Mutual funds, real estate investment trusts (or REITs) and any other oddball securities are less troublesome, but they also present problems. Investment clubs work best when they’re 100 percent stock-based.

11. The club treasurer isn’t recording the proper ex-dividend dates for the security dividends. Despite the changes in tax law that took effect in 2013 impacting the tax treatment of dividends, some taxpayers still qualify for lower taxes on some dividends. As a result, it’s still important for treasurers to record the accurate ex-dividend dates on all security dividends received. Treasurers who are guessing about these dates or who don’t take the time to look them up properly are taking a dangerous shortcut and will feel the pain at tax time when the club’s brokerage statements don’t match the club’s books.

12. The club doesn’t use a consistent method for selecting stocks and managing its portfolio. Consistency counts, whether you’re perfecting your golf swing, tennis backhand or homemade bread recipe. Change one variable or skip one ingredient, and the results may not be at all what you expect. In investing, a disciplined approach contributes more to success than nearly any other variable. Investment clubs that don’t take the time to de­velop an investment policy statement or determine their own guidelines for making purchase and sale decisions are only “playing” in the market, and the portfolios they build will be only as solid as castles made of sand.

Most investment club veterans wouldn’t be a member of a club that employed any of the bad practices discussed here. If your club does, I suggest that members decide once and for all if they’re serious enough about the endeavor to make the changes nec­essary to support a long (and prosperous) life of investing.

Douglas is ICLUBcentral's product manager, helping develop the company's programs including Toolkit 6, myICLUB.com, and the Investor Advisory Service. He is also the author of several investing books, including The Pocket Idiot's Guide to Direct Stock Investing, The Complete Idiot's Guide to Online Investing, The Armchair Millionaire, and Investment Clubs for Dummies.